Joseph V. Rizzi Amsterdam Institute of Finance December, 2015

22 Cash Flow Impacts default risk Balance Sheet Determines Loss in Event of Default (LIED) Liquidity Valuation Amsterdam Institute of Finance December, 2015

3 Business Risk: EBITDA Volatility ◦ Industry Characteristics ◦ Firm Characteristics Financial Risk: EBITDA Relative to Debt Structural Risk ◦ Issues  Priority of claim on assets and income  Control ◦ Focus  Covenants, Seniority, Security Amsterdam Institute of Finance December, 2015

4 Quantitative ◦ CapitalizationROTPre Crisis Crisis  Cash Equity>25% <25% 40%+  Total Debt 6% <5%  Senior Debt (1) 5% <4%  First Lien 4% <4%  Second Lien 1% __ ◦ Cash Flow  LTM EBITDA / PFI>2:1  7 x LTM FFOCF / TLA (2) >1:1 ◦ Liquidity  Cash + MS + RCA / P+I (3) > 1.5 : 1 1:- TLA usually >20% of senior debt and amortizes at least 30% by year 5 2:- FFOCF = LTM EBITDA - (WCI + CAPEX + Taxes + PF Interest) 3:- Liquidity tested day 1. MS (Marketable Securities). RCA (Revolving Credit Availability). Revolver usually set at 1 x EBITDA Amsterdam Institute of Finance December, 2015

5 Debt capacity is derived from firm’s assets ◦ Operating Cash Flows ◦ Asset Sales / Asset Quality ◦ Leveragability Market Conditions Target financing structure Credit curve shifts over time dependent on the economy, e.g., CCCSpreads ,300 Current 750 Rating Rates 2H07 Crisis Overheated 1H07 Amsterdam Institute of Finance December, 2015

6  There are two different approaches to designing the capital structure: 20% 30% 50% Cash Flow Cash Flow Model Model Balance Sheet Balance Sheet Model Model Senior Debt Sub Debt Equity 3 - 5x EBITDA 5 - 6x EBITDA Equity Amsterdam Institute of Finance December, 2015

7 Ratio Approach Cash Flow Advance Rate Amsterdam Institute of Finance December, 2015

8 Market ◦ Maximum senior debt and total debt ratios ◦ Vary over cycle Peers ◦ Identify ◦ Rating Classification ◦ Key Ratios Rating Agencies ◦ Credit Statistics Amsterdam Institute of Finance December, 2015

9 Amsterdam Institute of Finance December, 2015

10  Important:Loan Market Evolution from a bank to an institutional market (back to a bank market?)  Impact:Majority of syndicated loans are rated  Pricing:Affected by rating  Market Access Amount:Impacted by rating Amsterdam Institute of Finance December, 2015

Amsterdam Institute of Finance December,

AAAAA ABBBBB BCCC EBITDA/I <1 FD/EBITDANM >6 SizeBig20B+15B+10B+5B+1B+NM 12 Amsterdam Institute of Finance December, 2015

13  Maximum debt capacity formula:- MDC = f(operations, amortization, rate, asset sales) MDC = [EBIT / (i+ 1/n)] + AS + RF EBIT- Earnings Before Interest and Taxes i - Interest Rate n- Straight line loan amortization AS- Proceeds from Asset Sales RF- Refinancing Amsterdam Institute of Finance December, 2015

 Opening Balance Sheet  Adjustments – from sources and uses – including purchase price assumptions  Proforma balance Sheet  Income Statement  Cash Flow Statement  Capitalization table/transaction structure  Debt Schedule  Term sheet(s)  Valuation/maximum purchase price  Returns Analysis – IRR and MOC 14 Amsterdam Institute of Finance December, 2015

15  Issues ◦ Adjustments (beware of solving for cash flows to justify price) ◦ Normalization  Cyclicality  Bad Management  Value Test ◦ Projections implied price  Reverse Engineer - Management implied forecast ◦ Firms ◦ Peers  Tie Into ◦ Compensation ◦ Covenants Amsterdam Institute of Finance December, 2015

Comparison Corporate Private Equity Rating – I/G Maximum Debt Capacity – NIG Capital Market Access Temporary Permanent IRR EPS Control Flexibility – covenants, dividends Upside Pricing Value Transfer/Mispricing Reason Differing motivations 16 Amsterdam Institute of Finance December, 2015

Tradeoffs Amount Cost Flexibility Control Dilution Mispricing Issue Operationalize Ratings Target Comparative Credit Analysis Cash Flow Testing Market Conditions 17 Amsterdam Institute of Finance December, 2015

18  Macro/Market Level ◦ Determine rating target ◦ Use target rating level financial characteristics  Funded Debt/EBITDA  EBITDA/Interest Expense  Funded Debt/Total Cap Example: (A) Target RatingBB (B) EBITDA/Int for Target Ratingc3.0x (C) Firm EBITDA$300mln (D) Interest Rate for Target Rating10% (E) Maximum Debt Capacity= (C/B)/D = (300/3)/10% = $1,000 Amsterdam Institute of Finance December, 2015

 If EBIT > 5mlm – Debt Preferred  If EBIT < 5mlm – Equity Preferred 19 EPSEPS EBIT 0 5,000,000 10,000,000 Indifference Point Amsterdam Institute of Finance December, 2015

Year % (YTD) 0 20 Amsterdam Institute of Finance December, 2015

Euro U.S (9 Mos) Amsterdam Institute of Finance December, 2015

UKFrance Germany Equity42.5% 40.1% 37.8% Bank Debt51.5% 44.0% 49.6% 2L 1.7% 1.7% 1.9% HYB 2.4% 11.3% 10.7% MEZ % --- Other 22 Amsterdam Institute of Finance December, 2015

BB/BB- EuropeU.S. Pro Rata SpreadN/AL Weighted Avg Institutional SpreadE+294.4L Deal Size (€MM)1, , Pro Rata Term (in Years)N/A4.89 Institutional Term (in Years) Revenues (€MM)3,5766,448 EBITDA (€MM)9591,722 Pro Forma Debt/EBITDA Pro Forma Senior Debt/EBITDA Pro Forma Cash Interest CoverageN/A6.23 Observations632 B+/B EuropeU.S. Pro Rata SpreadE+346.4L Weighted Avg Institutional SpreadE+408.9L Deal Size (€MM) Pro Rata Term (in Years) Institutional Term (in Years) Revenues (€MM)2,1411,350 EBITDA (€MM) Pro Forma Debt/EBITDA Pro Forma Senior Debt/EBITDA Pro Forma Cash Interest Coverage Observations59181 Source: S&P Capital IQ 23 Amsterdam Institute of Finance December, 2015

Source of Funds Key TermsComments Bank Debt Typically 30 – 50% of capital structure Based on asset value as well as cash flow LIBOR-based (i.e., floating rate) term loan LIBOR floor; pricing grids 5-8 year maturity, with annual amortization often in excess of that which is required (average life 4-5 years) Up to 5X LTM EBITDA (varies with industry, ratings and economic conditions) Usually secured by assets and pledge of stock Maintenance and incurrence covenants; cash sweeps Bank debt will also include an unfunded revolving credit facility to fund working capital needs Can be split into Term A (shorter term, higher amortization) and Term B (longer term, nominal amortization, bullet payment) Generally, no minimum size requirement Amortizes over the life of the loans Generally, no prepayment penalty 2L Cov-Lite High-Yield Subordinated Debt Typically 20-30% of capital structure Generally unsecured Fixed coupon; PIK; PIK-T May be classified as senior, senior subordinated or junior subordinated Longer maturity than bank debt ( years, with no amortization and a bullet payment) Incurrence covenants Holding company obligor Public and 144A high yield offerings are generally $150mm or larger; for offerings below this size, assume mezzanine debt. In some cases, it may be appropriate to include warrants such that the expected IRR is 17-19% to the bondholder Senior and senior subordinated offerings are generally cash-pay; junior subordinated offerings (which would generally be issued in combination with senior subordinated offerings) may be zero coupon and issued at a holding company Bullet payment (non amortizing) 24 Amsterdam Institute of Finance December, 2015

Source of Funds Key TermsComments Mezzanine Debt Can be preferred stock or debt Convertible into equity IRRs in the high teens to low twenties on 3-5 year holding period Occasionally used in place of high-yield debt Generally a combination of cash pay and PIK; can be both, or change over time Often includes warrants to enhance IRR to desired level above coupon rate Total Debt Typically 3.0x-7.0x LTM EBITDA Interest coverage at least 2.0x LTM EBITDA/first year interest Total debt varies by sector, market conditions, and other factors Common Equity Typically 20-35% of capital structure 20-30% IRR on about a 5-year holding period Exit multiple = entry multiple Management options of 5-10% Required IRR may be lower for larger or less risky transactions Exit: IPO, Trade, STS, Recap 25 Amsterdam Institute of Finance December, 2015

SourcesUses Excess Cash Debt assumed by the buyer Minority interest assumed Revolver Term Loan A Term Loan B Senior notes Mezzanine preferred stock Subordinated (high-yield) notes Mezzanine debt Seller notes Preferred stock Common equity (sponsor’s investment) Management equity roll-over Investor roll-over Equity Purchase Investor roll-over Fund target’s cash balance Assumed (roll over) debt Refinance short-term debt Refinance long-term debt Assume (roll over) minority interest Purchase (buy out) minority interest Transaction fees and expenses Financing fees 26 Amsterdam Institute of Finance December, 2015

Virtual Datarooms (Merrill) Accounting McKesson / HBOC Enron HP / Autonomy Valeant Business Licenses Employment Leases EPA Insurance Legal Contingencies Certificates of Incorporation Buy Laws Minutes Patents, Trademarks, Copyrights, and Licenses Litigation Matters Lien Searches 27 Amsterdam Institute of Finance December, 2015

Amsterdam Institute of Finance December, Bull Market Menu Bear Market Menu As the credit curve shifts, the menu that is available to Issuers / Arrangers changes Tranche Term Loans Covenant Light High Yield Debt Holding Company PIK Bridge Loans Second Lien Hybrid Preferred Cross Lien Facilities Asset Carve-outs OPCO/PROPCO Recapitalizations Stretch Senior Seller Notes Senior Notes Private Placements Equity R/C Lite Mezzanine Smaller floors Sweeps Prepayment penalties covenants Issuer Friendly Investor Friendly Bull Market Menu

Impact of Debt Capacity on Purchase Price Multiples 29 Amsterdam Institute of Finance December, 2015

Leverage and Pricing in Buyouts dependent on credit market conditions Opportunistic Pro Cyclical Overpay when credit access is easy leading to lower buyout returns dependent on fund vintage Amount Pricing Investor risk appetite determines credit market conditions Capital structure decisions differ for corporates and sponsors Link between organizational form and financial policies Agency problems between PE general partners and limited partner investors may be an issue Amsterdam Institute of Finance December,

Strategic Buyers Pricing Primarily a function of synergies Debt Capacity Financial Buyers Pricing Primarily a function of Debt Capacity (FD/EBITDA)*EBITDA + Equity + Asset Sales Developing the Funded Debt Multiple: Market Driven Maximum Debt Capacity = [EBITDA/(I +1/n)] + Asset Sales Multiple = 1/(i + 1/n) as rates go up debt capacity declines Increasing Debt Capacity: i= by decreasing interest expense (rates + spread) 1/n= by lengthening duration maturities through changes to the structure (bridges, hybrids, etc.) 31 Amsterdam Institute of Finance December, 2015 Developing the Funded Debt Multiple: Market Driven Maximum Debt Capacity = [EBITDA/(i+1/n)] + Asset Sales Multiple = 1/(i + 1/n) as rates go up debt capacity declines Increasing Debt Capacity: i= by decreasing interest expense (rates + spread) 1/n= by lengthening duration maturities through changes to the structure (bridges, hybrids, etc.)

Assuming an acquisition where the Target’s EBITDA is $100 min, the maximum Purchase price that could be paid given the sponsor’s desired level of equity injection and the amount of leverage that the market will bear. Equity Contribution 32 Amsterdam Institute of Finance December, 2015 Leverage Multiple 10%15%20% 25% 30% 35% 40% 3.0x x x x x x x , x ,0001, x ,0001,0771, x ,0001,0711,1541,250

As can be seen below, when the leverage multiple decreases, the required equity contribution can increase significantly. Depending the buyers internal rate of return requirements, this may or may not cause them to abort the transaction. Equity Contribution 33 Amsterdam Institute of Finance December, 2015 Leverage Multiple 10%15%20% 25% 30% 35% 40% 3.0x x x x x x x , x ,0001, x ,0001,0771, x ,0001,0711,1541,

The shaded area of the chart below reflects the financing gap that develops when leverage multiples do not keep up with increasing purchase price multiples. As we will see later, some innovative securities have been developed in order to close the financing gap. Debt Multiple 34 Purchase Price Multiple D (40) (90)(140) (50)(100) (10) (60) (20) Amsterdam Institute of Finance December, 2015